Narodowy Bank Polski will not allow high inflation to become entrenched and, once specific conditions arise, is ready to withdraw the monetary accommodation. But for now, given the nature of inflationary shocks and uncertainty about the pandemic, this would be very risky – Governor of NBP Adam Glapiński told PAP Biznes.
1. Most economists and certain members of the Monetary Policy Council call for the start of a cycle of interest rate increases, citing high inflation. When is the earliest that NBP should decide to withdraw the monetary accommodation, and how could the process of interest rate hikes proceed, in terms of its pace, scale and the target level?
Governor of NBP Adam Glapiński: Let me remind you that the NBP monetary policy easing in 2020, and then maintaining the monetary accommodation in the current year, were a response to the unprecedented global health, social and economic crisis triggered by the COVID-19 pandemic. The Bank knows today that the measures proved effective and provided support to Polish enterprises and households. That helped the Polish economy recover from the COVID-19 pandemic crisis much faster, with lower losses than in other European countries. The success is also due to the central bank and an appropriate monetary policy. Let me say it again, without large-scale monetary policy easing during the pandemic, Poland would now be in a much worse condition, with much higher unemployment, bankruptcy of many companies, substantially lower economic growth, lower wages, a significantly worse fiscal position and higher credit losses of banks. So, this is what you should start with when discussing monetary policy, also today when the pandemic is not yet over.
At present, the Polish economy has recovered a significant part of the pandemic-related losses, which many commentators take for granted and at the same time pay attention solely to inflation. NBP analyses inflation processes very thoroughly. NBP takes inflation very seriously and it is at the centre of our attention, because the basic objective of the activity of NBP is to maintain price stability. However, let me remind you that inflation may, from time to time, run above or below the inflation target, including also outside the defined band for deviations from the target due to macroeconomic shocks occurring in the economy. The monetary policy response to these shocks must be flexible, as it depends on their causes and an assessment of their sustainability.
In the event of inflation deviating from the target, NBP determines in a flexible manner the desired pace of the return of inflation to the target. This is because the good of the Polish economy matters most and bringing inflation back to the target quickly may involve substantial costs. And what’s more, when making monetary policy decisions, the Bank also has to consider the lagged impact on the economy and inflation. This transmission lag usually amounts to several quarters and may change over time.
That is why when answering your question whether elevated inflation requires tightening monetary policy now, you need to start with an analysis of the causes of inflation and the central bank’s potential impact on the current level of inflation. Next, you need to consider what the inflation outlook within the monetary policy horizon is.
Well, the price growth currently observed is to a large extent independent of domestic monetary policy. Firstly, this is the effect of strong growth in commodity prices in the global and European markets, including the prices of crude oil, gas and metals, and recently, which is an unfortunate development, of agricultural commodities. This is coupled with a domestic increase in the regulated prices of electricity, related to the EU climate policy, and waste disposal charges. Lastly, the prices of some goods are pushed up by disruptions in the global supply chains caused by the pandemic, downtime in the manufacturing industry, and disruptions in international transport. All these factors are beyond NBP’s control and therefore it cannot mitigate their impact. What’s more, all of them are negative supply shocks, which means that on the one hand, they drive up costs and prices, and on the other, they hamper economic growth. Let me say this again: no matter how NBP tried to lower these prices, it has no tools to do it. Through its monetary policy, the central bank can influence aggregate demand in the economy, but this demand has only just returned to its pre-pandemic level. Furthermore, Poland is still far from the levels that would have been achieved if the pandemic had not pushed the economy off the sustainable growth path that Poland was on prior to the outbreak of the COVID-19 virus.
Therefore, central banks are now primarily interested in whether the post-pandemic economy will develop fast enough to produce strong and, above all, sustained demand pressure resulting in the inflation rate remaining above the inflation target permanently. Because only such inflation, which is driven by a rise in demand related to the good economic situation, can be reduced by the central banks without generating high costs to the economy and the labour market. What we are observing today is the realisation of pent-up demand after the pandemic. It is important to what extent the demand will continue in the longer perspective, when households have already caught up with what they could not do during the pandemic – mainly using some services. Therefore, many central banks are primarily thinking about the inflation outlook within the monetary policy horizon.
For the time being, we are facing another wave of the pandemic whose economic fallout is unknown. That is why most central banks are in no hurry to tighten monetary policy. At the same time, all forecasts show that the rate of price growth will decline next year. Obviously, the scale of the decline in inflation will most likely be curbed by, among others, further increases in electricity prices, but also by demand pressure, so inflation may remain markedly above the level of 2.5%. The Bank does not yet know how strong and lasting this pressure will be.
From NBP’s point of view, what matters most is how the economic situation will develop next year, how the labour market will look and how this will impact inflationary pressures. If economic conditions remain very good, the situation in the labour market remains favourable and inflation exceeds NBP’s inflation target, then it will be justified to withdraw the monetary accommodation. For the time being, given the nature of the shocks that are pushing up inflation and, at the same time, the very high uncertainty about the course of the pandemic and economic conditions, monetary policy tightening would be very risky. Therefore, it does not make sense to speculate now about the possible pace of interest rate hikes or the target interest rate level, and even more so about their “normalisation”. All will depend on the economic situation of Poland and inflation, as well as on changes in the environment of the Polish economy. One thing I can firmly assure you is that the central bank is not ignoring elevated inflation and will not let it become entrenched. On the other hand, the pace at which inflation is lowered must factor in the economic and pandemic-related situation, and also the nature of the price shocks. także naturę szoków powodujących wzrost cen.
2. What conditions must be met for NBP to withdraw the monetary accommodation? Why not increase interest rates now? Does NBP see signs of demand-pull inflation?
Governor of NBP: A fast decrease in inflation, especially when it is pushed up by demand shocks, at the expense of halting economic recovery which has just begun, would be a very costly mistake now. Not to mention that the presently elevated annual inflation rate, which will remain at this level for some time, largely stems from past developments, therefore it is basically given. Obviously, once high inflation becomes entrenched, it will be justified to withdraw the monetary accommodation. The monetary policy response will aim to ensure that inflation will return to the target in the medium term.
In many economies across the world, inflation has been at its highest level for many years. Like in Poland, inflation in the United States exceeds 5%, with core inflation also high. In the euro area, inflation is 3% and is above the ECB inflation target, and yet there was even deflation in the euro area towards the end of 2020. In Germany alone, CPI inflation in August amounted to 3.9%, which is the highest level since 1993. Furthermore, the situation in these economies has significantly improved, the labour market is performing better, but despite this most central banks continue to pursue an accommodative monetary policy.
As I have said, what a number of countries share is that inflation is pushed up by global disruptions from the pandemic, including also the base effect. This concerns commodity prices, the shortages of many semi-products, which by the way is becoming a major problem that limits the production of many industrial enterprises. Due to the shortages of semi-products and other supply-related problems, coupled with rising commodity prices, Germany’s PPI inflation exceeded 10% in July and was the highest since the oil price shocks of the 1970s. In Poland, additional inflationary factors include increases in administered prices, primarily of electricity and gas prices as well as waste disposal charges. Obviously, the higher prices are also the result of the rebound of demand after the pandemic, which collides with the supply constraints. It is visible not only in the markets of certain goods, but also in certain services. However, it is very important to distinguish between a temporary rebound and a permanent rise in demand.
The main question is whether demand-pull inflation is permanent enough, whether its rise is strong enough to pose a risk of permanently high inflation. Let me stress again that if the optimistic scenarios prove right and subsequent waves of the pandemic have no big negative impact on the economy, the rate of economic growth remains high and forecasts point to inflation hovering permanently above the NBP target, then it will be justified to withdraw the monetary accommodation.
3. How does NBP stabilise inflation at the level consistent with its inflation target, as indicated by MPC press releases, since CPI exceeds 5%?
Governor of NBP: The Monetary Policy Council (MPC) always speaks of stabilising inflation in the medium term and not of the current index. Let me remind you that the NBP target is a medium-term target of 2.5% with a band of +/- 1 percentage point. As it has been explained in Monetary Policy Guidelines for years, due to macroeconomic and financial shocks, the medium-term inflation target means that inflation may temporarily run above or below the target and even run outside the band for deviations from the target. What’s more, the MPC points out explicitly that the response of monetary policy to the shocks is flexible and depends on their causes, and an assessment of how permanent their effects are, including their impact on inflation developments. In the case of inflation deviating from the target, the Council determines in a flexible manner the desired pace of the return of inflation to the target, as bringing inflation to the target quickly may entail substantial costs for macroeconomic or financial stability.
Since the start of my tenure as Governor of NBP, inflation has averaged at 2.3%, so it has been consistent with the NBP inflation target. In this period, there was an episode of deflation, and now inflation exceeds the upper limit of the target. Today, all forecasts indicate that inflation will decline next year. This means that its elevated level is temporary. This is the result of the unprecedented pandemic-related shock that hit the global economy.
Narodowy Bank Polski is stabilising and will continue to stabilise inflation in the medium term at the level consistent with NBP’s inflation target. However, you can also ask about the pace of bringing inflation down to the target. And its pace, especially given the negative demand shocks, cannot be overly fast, because it could undermine the economic recovery. As I have said, NBP is by no means ignoring elevated inflation, but the Bank has to apply remedies that are adequate to its causes and which, at the same time, do not weaken the Polish economy.
4. How do the parameters of the required reserve ratio fit into monetary policy tightening and when its current ones may be subject to change? What would be an optimal level of the required reserve ratio and its remuneration rate after the pandemic? Should the remuneration rate on the required reserve ratio be lowered further?
Governor of NBP: The main aim of the use of the required reserve system is to contribute to the stabilisation of short-term market rates. Therefore, as far as the required reserve system is relevant for monetary policy implementation, it is practically of no relevance to its restrictiveness. After the pandemic, the Bank may return to a higher level of the reserve, but its specific level is yet to be discussed. An appropriate required reserve ratio must take into account liquidity conditions in the banking sector and, at the same time, support the potential to effectively stabilise short-term market rates at a level required by NBP.
As far as the remuneration on required reserve funds is concerned, both the literature on the subject and practice of central banks in developed countries show that for the required reserve to perform its role of a stabiliser for money market short-term interest rates well, it should be cost-neutral for banks, that is, bear interest at the market rate. This means that in our realities the optimal level of the remuneration on required reserve funds is the level of the NBP reference rate, unless there are reasons to set the remuneration rate at a different level.
5. When could NBP end its asset-purchasing programme? Will NBP reinvest the capital from maturing bonds after the programme ends, and are ad hoc interventions possible on the bond market and on the FX market?
Governor of NBP: Many commentators have recently been wondering when the Fed or the ECB will begin to taper asset purchases. This is a natural question, considering that the banks are making purchases on a large scale. The ECB continues to buy securities at a value of EUR 100 billion per month, which corresponds to nearly 1% of the GDP of the euro area. On the other hand, the Fed purchases assets at a value of USD 120 billion per month. For comparison, in August NBP purchased bonds at a value of less than PLN 1 billion, or less than 0.05% of Poland’s GDP.
Narodowy Bank Polski already substantially reduced the scale of structural purchase operations of Treasury bonds and government-guaranteed bonds a long time ago. Over the last 12 months, the bank purchased fewer assets than in April 2020 alone, that is during the peak of the pandemic-related recession. All observes know well that, unlike the major central banks, NBP reduced the scale of purchases a long time ago. Therefore, NBP does not have to announce any reductions in the scale of purchases or any tapering of the programmes, because it has already de facto occurred. Furthermore, it would not be in line with the rules adopted by the Bank. From the very beginning of the NBP purchases, the Bank has consistently stuck to the rule according to which the deadlines and scale of the operations depend on market conditions. That is why NBP can adjust, on a daily basis, the scale of operations to the market situation which – as is well known – may change quickly amid the pandemic.
In a word, NBP is maintaining purchases, the scale of which is adjusted to market conditions. However, as NBP begins to withdraw the monetary accommodation and raise interest rates, the purchase programme will end. As to the re-investment of maturing bonds, the Bank can do it, but it is not decided yet – everything will depend on market conditions in the future.
6. Why does the MPC keep referring to the zloty exchange rate in the press releases following its meetings? What is the role of the exchange rate in NBP’s policy at the moment? How does NBP assess the current level of the zloty exchange rate?
Governor of NBP: The exchange rate is an important parameter and absorber of shocks in the Polish economy, as I have repeatedly pointed out. The zloty exchange rate is flexible, i.e. it is determined by market conditions; however, the central bank may intervene in the foreign exchange market. At the moment we are still dealing with the pandemic, and pandemic uncertainty persists – as I have already pointed out – which is the reason why we are not withdrawing monetary accommodation. Given this situation, an appreciation of the zloty would not seem beneficial to the economy, as it would partially wipe out the effects of the monetary accommodation. That is why for some time we have been reminding the public in the MPC messages that NBP may intervene in the foreign exchange market and that the potential interventions will depend on market conditions.
7. What are the current NBP forecasts for GDP and inflation, considering the latest GUS readings (flash inflation, GDP structure in 2021 Q2) in the horizon of the rest of this year and in the following quarters? What is the current balance of risks for GDP and CPI?
Governor of NBP: This is what we are going to discuss at our next MPC meeting. Generally, GDP and inflation data have not shown much change to the path of those variables itself in the successive quarters. Short-term inflation will probably run a little higher than in the July projection, but, as I have said, will start dropping off from the second quarter of next year. My one personal concern is the rise in gas prices and possible further energy price increases, as this would mean another negative supply shock.
In turn, as regards the prospects for the business climate, things look good – assuming, though, that the next wave of the pandemic will not hamper economic activity in any substantial way. The projection envisages GDP growth of 5% over the next 3 years. This would be a very positive scenario for Poland. However, whether it will materialise will depend on the path of the pandemic – and on global economic conditions. At the moment, some little chinks have appeared in the Chinese data and, to some extent, in those from the USA. Also our data have shown a certain recent weakening in the demand for some goods. In the same vein, investment in 2021 Q2 proved weaker than expected.
8. How does NBP assess the situation in the labour market and the wage pressure – concerns about a wage-price spiral have been voiced – in the context of monetary policy conduct? To what extent does NBP take into account the currently elevated inflation expectations?
Governor of NBP: The situation in the labour market can be assessed as generally good. At the same time, our research shows that wage pressure in enterprises in 2021 Q2 was still weaker than before the onset of the pandemic. We must also bear in mind that unemployment is still higher than before the pandemic, and employment – despite having increased – is lower. In addition, the state continues to support the labour market with extraordinary measures by continuing to subsidise some jobs.
On the other hand, what we are seeing now is robust GDP growth combined with rapidly rising labour productivity. As a result, the estimated 2021 Q2 unit labour cost growth in the economy declined substantially and might even have been negative. In manufacturing, the growth in unit labour costs has been negative for several months. So looking at the labour market, we don’t see any cost pressure coming, let alone a danger of the so-called wage and price spiral. Of course, enterprises’ expanding wage bills do add to inflationary pressure, yet in our current situation this is mediated not so much by the rising unit labour cost but rather by higher demand for goods and services. This will lead to a relatively rapid closing of the output gap in the Polish economy, which in our estimates is still negative. Of course this will happen only if our optimistic economic growth scenario materialises without being disrupted by a new wave of the pandemic.
As for the inflation expectations, they are strongly determined by current inflation levels. But, incidentally, in August the distribution of consumers’ expectations improved somewhat. Professional forecasters, on the other hand, know that inflation will decline next year, which is reflected in their forecasts.
9. What is the likely impact of the Polish Deal on inflation, GDP, and the labour market?
Governor of NBP: Work on tax changes under the Polish Deal is in progress. In particular, government officials have recently announced that the project will be subject to modifications with regard to the health contributions of entrepreneurs. Therefore it is too early for detailed assessments. I think that at the point when we have finalized the November projection and will be drawing up the Council’s Opinion on the draft budget for the next year, the full shape of the project will be known and then we will address its macroeconomic consequences.
In general, the submitted proposals will mean higher disposable income for most taxpayers, in particular those from the lower and medium-range income brackets. So, a certain consumption stimulus should be expected. On the other hand, the reduced tax burden will make occupational activity more attractive. By increasing labour supply, this may mitigate the wage pressure in the economy.
10. What is the significance for NBP monetary policy of the policy of the Fed, which has recently suggested (see the Fed Chairman speech at Jackson Hole) that it will not rush to taper the asset purchase programme, let alone raise interest rates?
Governor of NBP: The Fed is a global central bank, the central bank of the world’s largest economy, so naturally we monitor its monetary policy closely. Particularly considering that this policy has an overwhelming impact on the global financial markets, and thus also on global economic conditions.
We have our own monetary policy, of course, but some of the challenges the Fed is facing today are similar to those we are facing. Specifically, inflation in the USA is as high as in Poland, GDP has returned to the pre-crisis level, and yet the Fed continues its accommodative monetary policy. Incidentally, the Fed’s policy is far more accommodative than ours, as the Fed is still purchasing assets on a massive scale.
What Chairman Jerome Powell said at Jackson Hole was that heightened inflation will probably prove temporary and does not call for any action just yet. A premature tightening might be a major mistake, particularly amid the next surge of the pandemic. He pointed out that the structural factors which have weighed on inflation in the past few decades remain in place and will probably continue to dampen inflation after the pandemic turmoil has faded. This testifies to the Fed being mindful of the fact that the main concern of most central banks in the previous decade was inflation at depressed levels; there is awareness that the risk of inflation running persistently below the target will probably make its presence felt again soon.
At the same time, he said that if the elevated inflation were to become persistent, the Fed would obviously take due measures. We view things similarly. If a risk of persistently heightened inflation should emerge, the monetary policy stance will be tightened. At the moment it is too early for such actions: the uncertainty related to the pandemic is too high and our actions shouldn’t hamper the recovery that has barely begun. In his speech, the Fed chairman argued that inflation is elevated temporarily as opposed to permanently. He quoted five important arguments in support of this proposition. At the same time, he said that the Fed would monitor inflation developments closely, to assess whether it hasn’t misjudged the situation after all.
Neither can we make firm statements about the future, especially with uncertainty running so high. All the same, notwithstanding these difficult circumstances we have to make decisions about the parameters of monetary policy. Of course not changing these parameters is also a decision with important implications for the future situation of the Polish economy. My judgement is that inflation will be trending downwards next year, although it is difficult to say whether it will return to the target on its own accord. If not, we will still have time for an appropriate response without incurring too many losses. If, on the other hand, the pandemic disrupts the recovery, a premature monetary policy response would be very costly for the Polish economy. I hope this is a sufficient explanation of why we, like many other central banks in developed economies, are cautious about withdrawing monetary accommodation. (PAP Biznes)